What Legal Entity Fits Your Startup?
This blog post has been prepared by The Startup Garage for informational purposes only and does not constitute advertising, a solicitation, or legal advice. The information contained in this blog post is provided only as general information which may or may not reflect the most current legal developments; accordingly, information in this blog post is not promised or guaranteed to be correct or complete. The Startup Garage expressly disclaims all liability in respect to actions taken or not taken based on any or all the contents of this blog post.
Before your business can get started, you as an entrepreneur have to pick your startup’s legal entity. There are multiple forms of business structures that you should consider when creating your startup. They are:
- Sole Proprietorship
- General Partnership
- Limited Partnership
- Limited Liability Company (LLC)
When considering what legal business type to choose four things to consider are:
- The amount of control you want in your company
- The amount of liability you are responsible for
- How you will file your taxes
- Administrative requirements
What is a Sole Proprietorship?
A sole proprietorship is one of the simplest and least regulated legal entities. In a sole proprietorship you, the entrepreneur, have total control of the business. The only problem with that is that with great control comes great responsibility. The sole proprietor is responsible and as a result all of his or her business and personal assets can be at risk.
When tax day rolls around, the sole proprietor files his or her business taxes with personal income tax forms.The entrepreneur may want to change the type of business entity as the startup grows because it will significantly reduce the amount of taxes he or she pays. Other than that, there are limited administrative requirements. Also, you still need to get your fictitious business name and local business licenses!
Partnerships: What is the difference between a General and Limited Partnership?
The difference between a general and limited partnership is based on liability. General partners are each liable for all debts while limited partners are only responsible for the amount of money the put into the startup. The amount of control each partner has in the company is determined by a Partnership Agreement. Partnerships are known as a pass-through entity, meaning that each partners profits are directly taxed. There are some administrative licenses that need to be obtained, but there are limited record-keeping or tax filing requirements.
What is a Corporation?
A corporation is a legal entity that is under the authority of state law and is separated from the people who own, manage and control the business. The shareholders buy stock in the company and elect the companys directors who govern general affairs and elect officers to run the day to day operations. One of the reasons to incorporate is to protect yourself from debts. Debts cannot be collected from the officers, directors or shareholders of the corporation, but shareholders can be asked to guarantee the payments of the corporation.
The main drawback of incorporating your startup is the amount of tax preparation and administrative work you need to do. For-profit C corporations are double taxed, once on the income earned by the company and once on the shareholders dividends. The startup can become an S corporation and the corporation is not taxed, but the income and losses are passed through to the shareholders. To be eligible to be an S corporation, a startup must:
- Not have more than 100 shareholders
- Shareholders cannot be non-resident aliens
- Only have one class of stock
To learn more, you should visit the IRSs website. We have found that to incorporate a business attorneys charge $499 – $1,500 and each state charges a fee of $100 on average.
What is an LLC?
A LLC is a cross between a corporation and a partnership. It is owned by one or more interest holders, or members, who have management rights. Members can also assign certain managers to run the company who are not members and are only responsible for the amount of money they put in. LLC’s are taxed just like partnerships are, so earnings are given to owners and they are then taxed at their personal taxed rates.
Make sure you have an attorney advise you on what type of legal entity is best for your startup. This is a tough process for entrepreneurs to to by themselves, so we recommend that you get some advice from a legal expert.
That’s it for the legal portion of the Your Startup’s Pre-Launch Checklist series! Over the next few posts we will go over some of the marketing tools that you should have in place before your startup opens its doors. Tune in Thursday when The Startup Garage explains the importance of creating an all-star logo.